Doug Kass isn’t ordering a Code Red like Jack Nicholson’s character in A Few Good Men but he’s called one on the stock market.

The Founder & President of Seabreeze Partners Management is widely followed for his market commentary.

He knows from experience that bull markets are hard to kill and acknowledges stocks can go higher still so he’s not aggressively shorting the market.

But in these excerpts from a recent piece Kass details a litany of warning signs, as he sees them, that will eventually lead to an ugly end.

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by Doug Kass, Seabreeze Partners Management

Code Red

  • The market is in chaos and more unstable than many think, but most are ignoring it

 

  • The market averages are holding on by a thread

 

  • The supercharged Fed put is about to expire

 

  • Stocks are more overvalued relative to “fair market value” than at any time in recent history

 

  • Market participants have been bamboozled into buying speculative gewgaws with little value (read: GameStop (GME), AMC Entertainment (AMC), Canaan (CAN), Marathon Digital (MARA), Plug Power (PLUG), etc.)

Breadth has deteriorated markedly and many other technical indicators are signaling trouble ahead.

Many talking heads in the business media, investment “communities” (such as Reddit, WallStreetBets and Robinhooders) have sold traders and investors a bill of goods by pushing and sanctioning speculative gewgaws (read: SPACs [special purpose acquisition companies] – loaded with unconscionable fees and questionable acquisition strategies that follow high fees – and collateral cryptocurrency plays) because they briefly were dramatically outperformers.

When I was critical and shorted many of these stocks (some that are now down 75% in value), I was ridiculed and criticized.

A common refrain: “What, Dougie, these stocks are flying and you obviously don’t want to make money!

Most have swept these idiotic trades under the rug, but what is really scary is that they still think they were right.

Hell, even CEOs such as AMC’s Adam Aron have been fooled into suboptimal capital allocation strategies!

He should be fired from his job for kowtowing to a bunch of day traders (the daily volume in AMC’s shares routinely trades near or in excess to its float) and those who supported him should admit their big mistake (they will not).

With their demise, traders and investors (and the entire business media community) have glommed on to Microsoft and Facebook, Apple, Amazon, Netflix, Google (FAANG), taking those stocks arguably to inflated levels with little margin of safety.

Even bona fide antitrust issues (from both Republicans and Democrats) and threats have been entirely dismissed at this point.

The outperformance of these great franchises pose a potential threat to investors in them, for should a broader market decline occur they will become ATMs and could drop swiftly despite the protestations of many who are long them.

Remember, there is a pattern historically of the first becoming the last. In all likelihood we will see that pattern develop again, especially if interest rates gap higher from current levels.

Powell Poops

  • Beware of false prophets

 

  • Normalization of policy may prove to be market unfriendly

The Federal Reserve and our undisciplined political leaders on both sides of the pew have produced a potentially lethal and liquid cocktail that has lifted equities, fixed income, art, digital currencies and real estate to levels that are unsustainable and vulnerable.

The Fed is now behind the curve and its hastening readjustment to tighter policy likely lies ahead, and with it will be a hard hit to the markets at a time in which no one anticipates a large market drawdown.

The supercharged Fed put is about to expire.

On Wednesday I wrote:

It is important to note that while I believe the S&P 500 Index is measurably overpriced, I am still relatively small in exposure as measured in both gross and net terms.

 

This reflects (1) my respect for the unrelenting market strength, (2) my attempt to be more reactionary than anticipatory, and (3) a view that there is some possibility of a blow-off top at some point.

 

I currently think the highest probability scenario is that we are in a relatively narrow trading range with a bias toward profit taking (call it -3% to -5%).

Bull markets die hard.

But, given the ongoing market chaos, the remarkable narrowing of leadership and other technical conditions I am changing my highest probability scenario of a 3% to 5% market decline to a 5% to 10% decline.

Bottom Line

“Market vision is always 20/20 when viewed in the rear view mirror.”
– Warren Buffett

As Bob Farrell teaches us, there are no new eras or paradigms and excesses are never permanent.

Over history, markets reflect the balance between risk and reward. But it seems that we are in this new-world belief where risk doesn’t exist and the rewards are easy to be had.

I am not short enough.

Code Red.

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